S Corporations can be a great entity choice for your business. Even if your business is an LLC you can file a simple three page form with the IRS to ask to be treated as an S Corporation for your taxes. However, much like the mogwais from the 1984 classic Gremlins, they have very important rules that must be followed or else they will change from cute and adorable creatures to little green monsters filled with teeth and claws.
Perhaps the most overlooked rule is the salary requirement of an active owner. The tax advantage of an S Corporation is that profits are not subject to the 15.3% self employment tax that partnerships and disregarded entity owners generally have to pay. So shareholders have a monetary motivation to not pay themselves a salary because salaries are subject to payroll taxes of 15.3% (7.65% withheld from their salary and another 7.65% paid by the company itself). The IRS has said that, in no uncertain terms, this is unacceptable.
Active shareholders MUST pay themselves a salary commensurate with the active work they perform. Shareholders that do not do this can be subject to stiff penalties and extra taxes. Please consult a tax professional when determining what your salary should, and should not, be.
Gregory M. Daniels, CPA
Daniels Group CPA, PLC
Phone: (248) 855-8400
Cell: (248) 635-7564
www.danielsgroupcpa.com
NOTICE TO PERSONS SUBJECT TO UNITED STATES TAXATION: DISCLOSURE UNDER TREASURY CIRCULAR 230:
The United States Federal tax advice, if any, contained in this document and its attachments may not be used or referred to in the promoting, marketing or recommending of any entity, investment plan or arrangement, nor is such advice intended or written to be used, and may not be used, by a taxpayer for the purpose of avoiding Federal tax penalties.